Chapter Seven - Mining

By Reginald W. Ogden Nov 7 2008 12:11PM www.ultimategold.ca

NATURE OF MINERAL DEPOSITS: SCARCITY AND ABUNDANCE

Everything we use or consume is either grown or mined. Unlike agriculture or forestry, mines have a finite life. They can be likened to a snake devouring itself, with wasting assets gradually dying with each ton of ore extracted.

There are some limited exceptions in South Africa where several diamond mines have produced for over 50 years and are expected to produce for another 50 years. The Potash Corporation, in Saskatchewan, has mine reserves that, at current production rates, could last for 200 years; as close to an annuity for shareholders as it is possible to get.

The existence of mined deposits and their frequency and abundance in nature, corresponds closely with the chemical composition of the earth’s crust.

Silver, for instance occurs in nature 40 times as frequently as gold.

If we imagine a pyramid with high-grade at the apex and low-grade at the base, then we can easily see that as we lower the grade that is economic, then reserves go up exponentially.We should not be surprised to find the world awash in low-grade copper deposits that also include small amounts of gold, silver and molybdenum. As metal prices decrease, breakeven grades increase and reserves decline, as prices rise, breakeven grades decline and reserves increase.

CONVENTIONAL OIL & GAS DEPOSITS IN NATURE

Proficient Easily Discovered Developable Resources With Short Lead Times To Production Costs & Development Lead Times Increasing

As proficient easily recovered reserves are depleted costs and lead times to production increase and recoveries decline for new discoveries.

MINERAL EXPLORATION AND DISCOVERY

“The meek shall inherit the earth, but the strong shall retain the mineral rights.”
– Anonymous

“Mining is a business, but exploration is an adventure.”
– Frank Joubin

Mineral deposits are few and far between and still fewer people will bring a deposit into profitable production. The chances of bringing a raw prospect into production have been estimated at 1 in 5,000 to 1 in 10,000.

Some deposits eluded recognition for several decades, despite intermittent exploration of the same showings by several companies and, in many cases, claims staked by both seniors and juniors were allowed to lapse. There are many instances in which prospectors have revived old prospects and induced companies to drill just one more time before a discovery was made.

Often, exploration can be frustrating and time consuming. Texas Gulf tested 60 geophysical anomalies before a world-class discovery was made in Timmins, Ontario.

It took five years and an open-ended budget, for IMC to complete a shaft in frozen subterranean quick-sands to a depth of 3,500 feet. Once the technical problem was solved, other companies were able to take mines to production.

THE BASIC ECONOMICS OF MINING

“It takes up to a mountain with gold in it to get a handful of gold, is it worth it?”
– Appolonius

Resource development in the 20th century has been marked by the growth of largescale mining and technological development that enabled the use of economies of scale.

In 1887, the development of the cyanide process made possible the mining and recovery of lower-grade gold bearing ores and caused South Africa to overtake the U.S.A. as the world’s leading gold producing nation.

The 1960s and 1970s saw rapid advances in mobile equipment technology, which made open pit mining viable on a large scale. The most significant factor affecting the gold producer in the1980s and1990s was the size and scale of equipment. Carbon, in pulp-leach technology, permitted low-grade ores to be mined more cheaply. As a result of these technologies, companies such as Rayrock were able to mine ores with an average grade of 0.02 ounces per ton with a strip ratio of 5 to 1. Developments in milling, assaying and metallurgy also led to large-scale efficiencies that allowed lower and lower grades to be mined. Technological development enabled different types of deposits, such as refractory ores, to become mined economically.

To take advantage of the new economies of scale, many porphyry, copper and copper /gold projects had to be processed with large through-rates in order to be viable investments and pay back the large capital investment required.

GOLD AND BASE METALS PRODUCERS

The percentage of gold produced as a byproduct of base metals has steadily increased over the past10 years. It now represents close to 20% of total world bullion production. Until recently, the market has tended to treat such companies more as base metal stocks than as gold stocks. The world’s largest single gold producing mine, the Grasberg in Indonesia owned by Freeport McMoran, is essentially a primary copper producing mine with gold as a byproduct.

The supply/demand equation for base metals is different from that of gold. Unlike gold and oil, there is no restraint on inventory as they are easy to store, especially when interest rates are low.

When demand is soft, inventory is allowed to grow before production cuts begin to affect the level of inventories and as a result metal inventories display a strong inverse relationship to price.

Demand for basic metals correlates 90% to 95% to changes in industrial output. Societies undergoing rapid economic development see rapid increases in the use of both energy and base metals. Once they reach a certain level of prosperity, demand flattens out. The recent surge in base metals is primarily due to rapid economic development on the Asian continent.

When inventories stand at over 10 weeks of demand, prices are not materially affected. When inventories reach below10 weeks of demand, price change escalation can be swift and large. For an inventory reduction from ten to eight weeks of supply, prices can move up 20% to 50% and when below seven weeks can escalate in excess of 100%. Once metal prices begin to move in a steep curve, they can become exponential as fear of shortages escalates.

Until the recent upsurge in Asian demand, the base metal sector, unlike precious metals, has been in a long-term secular downtrend that began in 1939 with primarily Europe, North America and Japan having low-cost access and use of world resources. The rise of Asia as an economic power has now changed the worldwide supply/demand equation and in the process, transformed base metals into a growth industry for the next 10 to 20 years. Once India and China emerge from the current phase of rapid physical production, base metal demand should stabilize as it did in the western world.

Although the per capita GDP of North Americans has increased substantially over the past 50 years the physical weight of the GDP has remained relatively stable over time with quality and miniaturization substituting for quantity. The lighter the output the easier it is to move. The physical weight of individuals has been increasing over time, but GDP is downsizing and getting lighter with quantity over quality.

BASE METAL EQUITIES

Canadian institutions tend to keep core positions in base metal equities, as mining is such a large part of the market and economy in Canada. As a result, Canadian base metal stocks tend to peak when American and non-Canadian ownership is at its highest and bottom out when Canadian ownership is at its peak. Historically, this has been true over the past 30 years with both Alcan and Inco.

GOLD AND PRECIOUS METALS PRODUCTION AS A BYPRODUCT OF LARGE SCALE BASE METAL PRODUCTION

Prior to 2001/2002, base metals were in a secular bear market with growth of production slow and heavily cyclical. The importance of gold, silver and platinum as a byproduct has increased steadily over the past10 to 20 years to represent 20% of the gross value of base metal mining operations. The revival of demand for base metals throughout Asia see this percentage steadily increase over the next 10 to 20 years.

It is preferable for precious metals to be able to report to one concentrate form than to several concentrates. They are more valuable when they are contained in copper or lead concentrates than they are in zinc concentrate. The lead smelter can pay up to 85% for silver contained in a lead concentrate but a zinc smelter will pay little if anything to the miner. As a rule of thumb, only 50% of the gold in base metals concentrates is recoverable.

The value of the Net Smelter Returns (NSR) is determined by mill recoveries, concentrative grades, freight charges and penalties for impurities.

To be economic, the Net Smelter Return should be twice the operating costs. Funds over and above the NSR are needed to recover capital, to pay interest expenses, taxes and dividends (if any).

Companies and writers are often careless or imprecise in the use of geological and mining terminology, especially in describing an ore body and often fail to dis - tinguish clearly between reserves and resources. The word “reserves” is essentially an economic rather than a geological term. One of the most common errors is to include several minerals as gold equivalent and then argue that the base metals and other minerals lower the cost of producing gold. Often they include the gross value of the base metals, not the value or NSR after smelting. Such reasoning can often give us a low or zero cost of production of precious metals, which is unrealistic.

MINING RULES OF THUMB

Webster’s dictionary defines a rule of thumb as a “general or approximate principle, procedure or rule based on experience or practice as opposed to a scientific calculation or estimate”.

The very first outline of such rules was in the Latin text De Re Metallica authored by Georgius Agricola in 1556. Until Schluter’s text on metallurgy in 1738, it had no equal. In the text, Agricola outlined the principles of smelting and the concentration of metal ores.

The term economic or commercial is very misleading; it merely means that an investment can be recovered over time. That time frame, however, can be extended over a long period, which reduces the real rate-of-return to low single digits.

Mining Rules of Thumb

• To be profitable and show a healthy rate of return and repay capital, gross revenue should be two times the cash cost for a new mine going into production.
  
  
• On vein systems, the old mining adage, “drill for structure, drift for ore”, holds true. Drill holes into veins with erratic or concentrated ore shoots can lead to seriously underestimating or exaggerating of the ore grade. In many gold vein deposits, erratic localized occurrences of course gold make sampling and assaying difficult and may require bulk testing.
  
  
• An underground mine needs at least 200,000 tons to justify being placed into production. A zone or intersection should be economic if the grade times the width (in feet) exceeds the factor of three – e.g. 7ft. of 0.60 ounces of gold = 4.2. This rule varies with gold prices and the characteristics of each deposit, but a lot of failures occur when this rule is ignored.
  
  
• Expect and plan for 2% to 5% losses to occur in the milling process. Gravity recovery leads to losses of 3% to 5%, under even ideal conditions. Even the most efficient refiner may lose 3% to 5% in the smelting process.
  
  
• The finer the material, the better leaching works.
  
  
• Large low-grade open pit successful operations are as much a factor of engineering and management as they are of geology. Specific gravity work ratios and metallurgy are just a few of the myriad of factors the engineer has to consider.
  
  
• Much of this information is not made public and the investor has to rely on the reputation and credibility of the engineering company writing the feasibility report.
  
  
• Allow for environmental “front-end-costs” to be added to the capital cost of the operation and allow for similar expenses at the close of operations at the end of the mine’s useful life.
  
  
• Minimum open pit grade should be one gramme per tonne.Minimum underground grade should be eight grammes. In South Africa, the majors have farmed out most of the eight gramme and below properties to independents and kept the 11 to 13 gramme underground mines.
  
  
• For a mining project to be successful, it should be exceptional in at least two dimensions, such as low strip ratio, high-grade, simple metallurgy or existing infrastructure.
  
  
• Beware of comparing grades of previous producers to grades of current mineral deposits. Many of the extremely low-grade porphyry copper mines in British Columbia were placed into production prior to the discovery of the larger higher grade copper /moly and copper /gold porphyry deposits in Chile.
  
  
• Mining is one of the few economic endeavors where old mill plant equipment is still economic. As a rule of thumb, a second hand mill can be relocated and rebuilt at half the cost of a new one and with similar productivity levels.
  
  
• For gold mines, typically 85% to 95% of the gold can be recovered on site.
  
  
• In geophysics, E-M is used to detect semi-massive to massive sulphides. IP to detect disseminated minerals.
  
  
• Fifteen to 30% of total world gold resources exist in refractory ore,which is difficult and expensive to recover.

ASSAYING AND ASSAY INTERPRETATION

In order to provide a conservative estimate of ore grade, both the frequency and distribution of high-grade assays should be carefully monitored and measured.

One needs to be very wary of high-grade intersections that are averaged out over large core lengths to create 'stretch assays', which can be misleading. Assays should include low-end cut off grades – i.e. a minimum cut off grade, grades by intervals and culling of maximum grades. No separate intersection should be reported as a continuous length if any of its intervals assay below low-end cut off grades.

'Cut off' procedures vary from placing a maximum grade of say one ounce or cutting to two to four times the average grade. Always be careful of comparing grades of different lengths. Although the above rules apply to the vast majority of properties, on exceptional high-grade properties such as Goldcorp’s Red Lake Mine where extremely high grades were pervasive, most analysts cut the grade to one or 1.2 ounces. When in production, its average grade was between 2.2 and 2.6 ounces a ton. mThe astute investor could have added up each 20 or 30 foot section of the highgrade assays and realized that there was remarkable consistency over those lengths and recognized that the production grade would be much higher than the “conservative grade” estimated by analysts.

RULES OF THUMB FOR ECONOMIES OF SCALE FOR OPEN PIT MINING AND LARGE SCALE MINING

If we assume1,500 TPD is 100% of capital cost per ton of production factor.

1. Capital Costs

   1,500 TPD = 100%
   5,000 TPD = 185%
   25,000 TPD = 475%
   90,000 TPD =1150%

2. Total Operating Costs

   1,500 TPD =100%
   5,000 TPD = 68%
   25,000 TPD = 40%
   90,000 TPD = 27%

3. Capital Costs per Ton of Daily Production

   500 TPD =100%
   1,000 TPD = 65%
   1,500 TPD = 45%
   5,000 TPD = 24%

For large low-grade deposits, in order to optimize the scale of operation, it is necessary to block out reserves prior to production. With high-grade properties, a decision to go production can often be made without fully deleting reserves, as economics of scale are not as important. This leaves many high grade properties with large blue sky potential once they are in production, e.g. Goldcorp’s Red Lake Mine.

RULES OF THUMB FOR OPEN PIT MINING COSTS

• &Open pit mining haulage costs should be below 50% of the mining process costs and at or below 25% of total mining costs.
  
  
• The ultimate pit slopes and angles are determined as much by economics and engineering as they are by geological structure. The difference between 39 and 40 degrees in a 300 meter pit can be an extra 3.5 million tonnes of waste to be removed.
  
  
• In a large operation, grinding the ore can cost up to 40% of the total mineral processing cost. The total cost of grinding rises sharply with the fineness of the grind.
  
  
• It is cheaper to ship 8,000 kilometers by sea than 800 kilometers by truck.
  
  
• Mine reclamation can take up anywhere between 10% and 20% of total mining costs.
  
  
• When the mine has to use autoclaves, add $10.00 to $15.00 dollars a ton to the costs.

ECONOMIC RULES OF THUMB FOR UNDERGROUND MINING

Shaft sinking costs five times as much as drifting. Timbering, if it is needed, can add expense and time to drifting. Underground mining costs: The costs go down as the scale of operation chosen changes. The most expensive is Square Set, which we determine to be 100%.

Block caving can be, in certain circumstances, equivalent to open pit economics. Mining dilution is one of the most serious problems in underground mining There is almost always some waste mixed in with the ore depending upon the size of the slopes, usually about 15%.

MINING SUCCESSES AND FAILURES

According to a report in the Northern Miner, half of all mining ventures in the world can be classified as failures due to economic or technical reasons. The main reasons for this are lower gold and precious metals recoveries as well as lower reserves than forecast. One report done by Strathcona, for the years 1986 through 1990, showed that four out of five gold mines placed into production during that period were economic or technical failures, with seven major successes and 30 failures.

With large scale low-grade mining operations, it can be simple engineering malfunctions or erroneous assumptions, such as specific gravity, work ratios of the ore or even excessive abrasion of the ore during the milling process. In the case of Mascot Gold’s Nickel Plate mine, a viable small underground mining project was turned into a large scale open pit, which did not suit the geological structure of the more occurrence. In recent years,more stringent engineering feasibility requirements have reduced the number of failures but they still occur on a regular basis.

In a commodities boom beware of mining operations that combine high operating cost leverage with high financial leverage, a dangerous cocktail when commodity prices decline. A property that is debt free can be moth balled or placed on standby at very little cost. For many low grade heavily debt leveraged mines it becomes a case of “Gear today gone tomorrow”.

Reginald W. Ogden
Canaccord Capital Corp.